Europe Bond Curves Flatten as Inflation Softens, Supply Dries Up

  • Dearth of summer bond auctions as ECB buying continues
  • Look for carry in 30-year French, Italian bonds: NatWest

European bond curves are flattening as weaker core inflation and a lack of issuance over the summer puts pressure on long-end yields.

The spread between 5-year and 30-year yields in both Germany and France has tightened by around 20 basis points in the past two weeks, and hit the lowest this year on Thursday. Softer inflation on both sides of the Atlantic, coupled with falling oil prices and continued bond-buying from the European Central Bank, has seen market participants reaching for yield in longer maturities.

There is just 1 billion euros ($1.1 billion) in long-dated auction supply scheduled between now and the end of August, which follows a heavy period of long-dated issuance following the second round of the French election, when France and Italy rushed to syndicate bond sales. Meanwhile, the ECB’s bond buying will continue at the current pace of 60 billion euros per month at least until the end of the year.

That dynamic left NatWest Markets favoring 30-year Italian or French bonds, strategist Andrew Roberts wrote in a client note. Long-term yields are also being pushed lower by a repricing of global inflation risks, after a string of below-consensus core consumer-price readings in the U.S. and a recent drop in European inflation data.

“The demise of U.S. inflation infers a new bull flattening phase on the euro rates as well as USD,” Citigroup Inc. strategist Harvinder Sian wrote in a client note earlier this month, recommending buying German 30-year bonds and selling 10-year bunds.

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